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Author: alaskack Big red star, 1000 posts Old School Fool CAPS All Star Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 75335  
Subject: Inflation Hedges Date: 7/12/2007 7:21 PM
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I was going over my retirement planning on another board and I started thinking about expenses in retirement. I expect to have a mortgage for a few years after retirement and with it being a fixed rate mortgage, it doesn't vary except for the escrow account that gets paid with it. So, I'm thinking that my retirement income does not need to be fully inflation-proofed. For example, with a 3% average inflation rate, I figure I'd need to inflation-proof income somewhere between 1.4-1.7% . Of course, once the mortgage is paid off, I won't need the same level of income, so inflation will not be a major expense factor for many years.

What does this mean for retirement investing? Well, it means that my IRA balance doesn't need to be as large as I'm currently planning, since my withdrawals won't need to increase as much due to inflation. The real benefit is that inflation will compound at a lesser rate. For example, 1.5% adjusted inflation rate will need about 11% less in income than what's needed for a 3% inflation rate for ten years out.

One argument against using an adjusted inflation rate is healthcare. Healthcare costs have increased at a higher rate than the average inflation rate and it's likely that you'll utilize these services more often, so you have a double expense of rising costs and greater usage. But, for those of us with medical coverage through our retirement plan, these expenses should be controllable. Since many group plans typically pay 80% and then 100% above a certain limit, they are essentially inflation-proofed. True, there will be expenses not covered by insurance, but they should only be a small part of the total cost.

So, does this mean I'm going to cut the inflation rate I use for planning? No, I'll still use the 3% average. What it does mean is that if I'm under my IRA goal at retirement, I'm still likely to retire because my needs will be less. If I meet or exceed my retirement goals, I can use the inflation difference to set up a medical reserve fund. It's possible this reserve can grow to the point where I can drop the amount I budget for medical expenses, further reducing my income needs.

So, what do you think? Will I be risking my retirement?

Calvin
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